Basel to allow banks liquidity flexibility

Banks will be allowed to run down their liquid assets below the regulatory minimum in times of financial crises, the powerful international regulator, the Basel Committee on Banking Supervision, has decided.

But the committee has not budged on the 2015 start date for banks to hold more and higher-quality liquid assets such as government bonds, rejecting assertions from some international banks that the start date should be delayed.

Local banks will need to notify the Australian Prudential Regulation Authority if they intend to breach the liquidity coverage ratio (LCR), which is designed to ensure deposit-taking institutions have enough reserves to survive 30 days in the event of a crisis, up from the current five days.

The concession, not unexpected by bank experts, was announced after a weekend meeting in Switzerland of the Group of Governors and Heads of Supervision (GHOS), the oversight body of the Basel Committee.

Reserve Bank of Australia governor Glenn Stevens attended the talks.

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It also announced that for the first time each member country will be subjected to a detailed peer review of its implementation of all components of the Basel regulatory framework, that could raise prudential or level playing field concerns.

The move addresses criticisms that the Basel I and II reforms were not fully implemented by some jurisdictions, including the US, and enabled regulatory arbitrage that contributed to the financial crisis.

The development may go some way to placating Australian bankers, who argued they could be competitively disadvantaged if other countries do not follow through on their Basel III commitments.

GHOS chairman and governor of the Bank of England Mervyn King said in statement after the meeting: “The level of scrutiny and transparency applied to the manner in which countries implement the rules the committee has developed and agreed will help ensure full, timely and consistent implementation of the international minimum requirements."

“Many banks operate across international boundaries but if they’re not being supervised consistently then it’s going to undermine the stability of the system," Mr Dickinson said.

Peer reviews will begin in the European Union, Japan and the US in the first quarter of this year, but the timing of the review of Australia is yet to disclosed.

PwC banking leader Stuart Scouler said the peer review would try to keep the system consistent.

“Time will tell if countries fully adopt Basel III and that journey still has some way to go."

Australia’s financial sector will be scrutinised this year by a separate joint International Monetary Fund and World Bank analysis, through the Financial Sector Assessment Program, which is conducted every five years.

High-quality liquid assets, including central bank reserves and government bonds, are designed to be stored by banks for emergencies, so they can readily exchange the securities for cash to continue to pay out depositors and lend money.

Hence, dipping below the prescribed threshold in a stressed scenario caused by an external event is, in effect, using the stockpile for the desired intention.

The precise rules dictating what circumstances and how the liquidity coverage ratio can be breached will be the subject of discussion between APRA, the RBA and banks, so a set of principles can be established ahead of any future crisis.

The GHOS said there could be minor modifications to the LCR to address concerns, but noted these would “not materially change the framework’s underlying approach".

The considerations are likely to centre on run-off rates for retail and corporate deposits in a crisis and whether certain types of bonds qualify as liquid assets.

While the range of eligible assets might be extended to other securities like high quality corporate debt, APRA is unlikely to allow these to count for Australian banks due to the lower levels of liquidity in the smaller local market.

Due to a shortage of government bonds in Australia, reflecting low levels of public debt, the RBA will provide a committed liquidity facility for banks to make up the shortfall, in return for a small fee of 0.15 of a percentage point for drawn and un-drawn commitments.